A central bank is an independent authority of a nation that conducts monetary policy, regulates banks, and provides financial services to the economy. Central banks possess a monopoly on increasing the monetary base in a state, generally controlling the printing of the national currency. Most central banks have supervisory and regulatory powers to ensure solvency of member institutions and discourage reckless or fraudulent behaviour by member banks.
Central banks decide on monetary policies in a country to determine growth of the economy. Monetary policy aims to control the interest rate payable on short term borrowings or the money supply. The major target of monetary policies is often the inflation or interest rate to ensure price stability and trust in the currency. In addition, monetary policies aim to stabilise the gross domestic product, achieve and maintain low levels of unemployment and regulate exchange rates with other currencies. Monetary policy can either be expansionary or contractionary.
Functions of Central Banks
Central banks utilise three monetary policy tools to control liquidity in financial systems. They set a reserve requirement, use open market operations to buy and sell securities and set target interest rates to charge member banks.
Central bank creates and manage a peg that aims to help keep exporters prices competitive. They do this by storing currency in foreign exchange reserves. They then use the reserves to adjust exchange rates. The reserve currencies are usually the dollar or euro. Managing these foreign currency reserves help keep a nations currency in alignment. Central banks also regulate exchange rates as a way to control inflation. They buy and sell large quantities of foreign currency to affect supply and demand.
Governments create interest bearing assets which they sell to the public. The Central banks then issue interest free currency notes to buy the contracts attached to the interest-bearing assets. These assets are usually government bonds and treasury notes. Central banks sometimes purchase more bonds than their national government make available by buying private bonds or assets dominated in foreign currencies. Money is created in the process.
Negative Interest rates